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The Nonlinear Effects of Fiscal Policy

Author

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  • Pedro Brinca
  • Miguel Faria-e-Castro
  • Miguel H. Ferreira
  • Hans Holter

Abstract

We argue that the fiscal multiplier of government purchases in incomplete markets models is nonlinear in the spending shock, in contrast to the multiplier in complete markets models and what is assumed in most of the literature. In particular, the multiplier is increasing in the spending shock, with large positive shocks having the largest multiplier and large negative shocks having the smallest multiplier. The mechanism hinges on the relationship between fiscal shocks, their form of financing, and the response of labor supply across the wealth distribution. The model predicts that the aggregate labor supply elasticity is increasing in the fiscal shock, and this holds regardless of whether shocks are deficit- or balanced-budget financed. Our findings are consistent with aggregate fiscal consolidation data across 15 OECD countries over time. Furthermore, we find evidence of our mechanism in microdata for the US.

Suggested Citation

  • Pedro Brinca & Miguel Faria-e-Castro & Miguel H. Ferreira & Hans Holter, 2019. "The Nonlinear Effects of Fiscal Policy," Working Papers 2019-015, Federal Reserve Bank of St. Louis, revised 17 Feb 2022.
  • Handle: RePEc:fip:fedlwp:2019-015
    DOI: 10.20955/wp.2019.015
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    Cited by:

    1. Kopiec, Paweł, 2022. "The government spending multiplier in the Heterogeneous Agent New Keynesian model," European Economic Review, Elsevier, vol. 145(C).
    2. Brinca, Pedro & Duarte, João B. & Holter, Hans A. & Oliveira, João G., 2019. "Investment-Specific Technological Change, Taxation and Inequality in the U.S," MPRA Paper 91960, University Library of Munich, Germany.
    3. van der Wielen, Wouter, 2020. "The macroeconomic effects of tax changes: Evidence using real-time data for the European Union," Economic Modelling, Elsevier, vol. 90(C), pages 302-321.
    4. Fonseca, Miguel, 2020. "Fiscal Consolidations: Welfare Effects of the Adjustment Speed," MPRA Paper 98902, University Library of Munich, Germany, revised 02 Mar 2020.
    5. De Dominicis, Piero, 2020. "Routinization and Covid-19: a comparison between United States and Portugal," MPRA Paper 101003, University Library of Munich, Germany.
    6. Nadav Ben Zeev, 2019. "Identification of Sign-Dependency of Impulse Responses," Working Papers 1907, Ben-Gurion University of the Negev, Department of Economics.
    7. Zsurkis, Gabriel & Nicolau, João & Rodrigues, Paulo M. M, 2021. "The expected time to cross a threshold and its determinants: a simple and flexible framework," Journal of Economic Dynamics and Control, Elsevier, vol. 122(C).
    8. Kopiec, Paweł, 2020. "Employment prospects and the propagation of fiscal stimulus," Journal of Economic Dynamics and Control, Elsevier, vol. 117(C).
    9. Ferrreira, Ana Melissa, 2019. "Skill-Biased Technological Change and Inequality in the U.S," MPRA Paper 93914, University Library of Munich, Germany.
    10. Coelho, José, 2020. "Universal basic income and skill-biased technological change," MPRA Paper 99195, University Library of Munich, Germany, revised 20 Mar 2020.
    11. Bernardino, Tiago, 2019. "Asset Liquidity and Fiscal Consolidation Programs," MPRA Paper 93903, University Library of Munich, Germany.
    12. Vaz de Castro, Afonso, 2022. "Risk Aversion and Recessive Impacts of Austerity," MPRA Paper 111875, University Library of Munich, Germany.
    13. Faria-e-Castro, Miguel, 2021. "Fiscal policy during a pandemic," Journal of Economic Dynamics and Control, Elsevier, vol. 125(C).
    14. Vedor, Bernardo, 2022. "Investment-Specific Technological Change and Universal Basic Income in the U.S," MPRA Paper 111675, University Library of Munich, Germany.
    15. Tavares, Francisco, 2021. "Inflation heterogeneity and its impact on inequality: evidence from the United States," MPRA Paper 105461, University Library of Munich, Germany.
    16. Santos, Mariana, 2020. "The impact of labor income tax progressivity on the fiscal multipliers in the context of fiscal consolidation programs," MPRA Paper 98736, University Library of Munich, Germany.
    17. Freitas, Bruno, 2020. "Labour Share Heterogeneity and Fiscal Consolidation Programs," MPRA Paper 98973, University Library of Munich, Germany.
    18. Nóbrega, Valter, 2020. "Optimal Taxation and Investment-Specific Technological Change," MPRA Paper 98917, University Library of Munich, Germany.

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    More about this item

    Keywords

    Fiscal Multipliers; Nonlinearity; Asymmetry; Heterogeneous Agents;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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